China leaps forward on trade zone

By Zhang
Monan 張茉楠 /

Thu, Nov 14, 2013 - Page 8

At the end of September, a free-trade zone was established in Shanghai with the aim of marking the start of a new era not only of openness in investment, trade, and finance, but also of deeper Chinese integration into the global value chain. The zone promises to launch a new round of liberalizing reforms and help China’s economy adapt to the latest demands of globalization.

Over the next decade, global competition will come to be defined as competition over the global value chain. As the US and other developed countries pursue “re-industrialization” and the Chinese economy’s low-wage comparative advantage diminishes, China must re-establish its competitiveness by positioning itself at the top of the global value chain, which implies the need to promote trade and upgrade its industrial infrastructure.

This requires that China build a national value chain and elevate its manufacturing sector — which currently depends excessively on foreign research and development, imports of raw materials and semi-finished parts — and external demand. The manufacturing sector’s domestic value chain is woefully weak.

The Shanghai zone promises to facilitate progress in three crucial areas: First, it should improve the manufacturing sector’s localization rate for parts and components by accelerating the transmission of raw materials and intermediate inputs, as well as integrating export-oriented producers with domestic industries.

Second, in accordance with Beijing’s 12th Five-Year Plan, the free-trade zone aims to extend the industrial value chain, improve value-added content, promote the coordination of domestic and foreign investment in manufacturing, and strengthen the sector’s classification and assessment capacity. At the same time, it should preserve a level playing field by prohibiting rule changes and limiting the establishment of entry and exit barriers in various industries, in addition to using taxation, finance and brand authentication to cultivate core competitiveness.

Third, the zone should encourage multinational corporations (MNCs) to expand their Chinese operations beyond factories — China should be home to their design, distribution and service divisions. This would optimize relationships between parent and subsidiary companies, while prompting a shift from the simple production model of the past to a model characterized by integrated services and global operations.

Over the past decade, MNCs have increasingly expressed interest in establishing regional and global headquarters, and research and development centers in Shanghai. As of September last year, the city was home to 393 MNCs’ regional headquarters.

In this sense, China has a rare opportunity to expand its growth potential by stimulating domestic demand. The gradual improvement of its labor force in terms of skills and productivity, along with its relatively strong capacity to absorb high-value foreign investment, will drive the country’s economic development, while MNCs’ shift in strategic focus from Western markets to those in the Asia-Pacific region will transform the global value chain.

As the Shanghai zone becomes a global financial hub, it will have to determine how to attract high-level factors of production. To this end — in addition to its taxation, finance and trade facilitation policies — it should establish trade promotion mechanisms in the world’s major export markets so firms can build comprehensive networks of international trade service platforms and trade cooperation zones overseas.

China’s future competitiveness also depends on its integration into a new wave of global and regional regulatory regimes. Although there are several ongoing trade and investment negotiations — including the Trade in Services Agreement (TISA), the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) — Chinese policies remain largely defined by the traditional WTO framework.

However, the emerging arrangements would offer far more room for maneuver than the more restrictive WTO regime. For example, TISA negotiations in the fields of finance, securities and legal services have resulted in no restrictions on foreign ownership or the scope of business. Yet China’s adherence to WTO rules on foreign investment prevented it from participating in these negotiations, ultimately impeding its trade and investment ambitions. International politics were responsible for China’s exclusion from the TPP and TTIP negotiations.

Against this background, the Shanghai zone demonstrates China’s readiness to participate actively in global free-trade negotiations, with the goal of promoting a comprehensive free-trade strategy and safeguarding its interests worldwide.

Shanghai’s role in trade, finance, investment and shipping — together with an increasingly open service sector, improved regulatory environment and focus on institutional innovation — will lead to domestic market reform and drive China’s integration into new trade agreements.

The Shanghai free-trade zone’s final objective is to help China fully exploit the demand potential of its market. The country’s initial globalization “dividend,” accrued through low factor costs, is rapidly diminishing and a new era — characterized by a reliance on the domestic market to absorb foreign high-level factors of production, such as technology and human capital — is just beginning.

The task for China’s leaders is to expand policies aimed at boosting domestic demand, while improving the economy’s skills base and enhancing its relative capacity to absorb high-value-added, high-tech foreign investment. Advancing innovation-driven development and promoting emerging industries would improve the quality and level of foreign support and cooperation.

With rapid growth in the local market, China could become a leading source of global demand, a hub of high-level factors of production and a strategic center with the Shanghai free-trade zone at its core. At this level, the country would finally have the domestic value chain that it needs to sustain competitiveness and rapid economic growth.

Zhang Monan is a fellow of the China Information Center, a fellow of the China Foundation for International Studies and a researcher at the China Macroeconomic Research Platform.